Landmark human rights due diligence legislation agreed in EU

The Council and the European Parliament today reached a provisional deal on the corporate sustainability due diligence directive (CSDDD). The directive will set obligations for large companies regarding their adverse impacts on human rights and the environment, with respect to their own operations, those of their subsidiaries, and those carried out by their business partners.

The agreement is the result of a hotly contested legislative process in which the EU member states, European Commission and European Parliament had diverging views on scope and sanctions. Although the deal struck today may not be as broad as the original proposal, there’s little doubt that human rights and environmental due diligence will become mandatory for a large number of EU and non-EU companies.

The provisional agreement envisages a risk-based approach to human rights and environmental impacts, aligned with existing soft law standards such as the UN Guiding Principles and the OECD Guidelines.

The final wording of the provisional agreement is not yet available. We have put together this first high-level analysis on the basis of the Council’s and Parliament’s press releases and press conference.

Scope

The directive will apply to large EU companies that have more than 500 employees and a net worldwide turnover of EUR150 million. For non-EU companies, the threshold is set at a EUR300 million net turnover generated in the EU, 3 years from the entry into force of the directive. The Commission will have to publish a list of non-EU companies that fall under the scope of the Directive. A lower threshold (250 employees and EUR40 million turnover) applies for high-risk sectors, which include the manufacture and trade of textiles, agriculture, manufacture of food and trade of raw agricultural materials, extraction and wholesale trade of mineral resources or manufacture of related products and construction.

It would be a mistake to think smaller companies are not impacted by the directive. The directive mandates due diligence in respect of a company’s own operations as well as those of its business partners, which includes smaller companies too. Through contract provisions, codes of conducts and due diligence requests, these will equally be affected.

Financial sector

The inclusion of the financial sector was a hotly contested issue in the trilogue negotiations. The deal struck between the EU co-legislators is a typical European compromise: the financial sector will have to apply upstream due diligence, but is for now exempt from performing due diligence on financed activities. The directive will contain a review clause for a possible future inclusion of this sector based on a sufficient impact assessment. The financial sector will also have to develop climate plans (see below).

Climate transition plans

The obligation to develop a greenhouse gas emission reduction plan (or climate transition plan) contained in article 15 of the EC’s proposal has survived the trilogue negotiations. Companies in scope are required to adopt and implement a Corporate Sustainability Reporting Directive (CSRD) aligned climate transition plan. We will have to await the precise wording, but this could potentially be very impactful. Large companies are now increasingly under a legal obligation to develop and implement plans to transition towards net zero in line with the Paris Agreement.

This is not the only requirement for climate transition plans in the wider sustainability policy landscape. A number of countries have either announced or are developing transition plan requirements, including the UK, which announced it would be making disclosure of climate transition plans mandatory in the lead-up to COP26, and whose Transition Plans Taskforce recently published final guidance on “the gold standard” for transition plan disclosure. The International Sustainability Standards Board (ISSB) IFSR S2 Climate-related Disclosures also explicitly refers to disclosure on transition plans; given the number of countries which have signaled their support for the ISSB approach to sustainability disclosure, this makes it more likely we will see similar requirements in other jurisdictions. The updated OECD Guidelines also contain an explicit transition plan obligation (see our previous blogpost here). The fact that the COP28 Global Stocktake Decision for the first time references the need to transition away from fossil fuels lends further support to this obligation.

Civil liability

Although little is known about the provisional agreement on civil liability as of yet, it is clear that the key provisions of the CSDDD will be able to be enforced in civil court in cases of negligence and intent. There will be a period of five years to bring claims, by those concerned by adverse impacts (including trade unions or civil society organisations). Directors’ duties have however been deleted from the directive. Regardless, directors will incur liability risks from failure to report on due diligence policies and actions under the CSRD.

Sanctions

In the event of a breach of the directive, companies may be ordered to pay fines of up to 5% of the company’s net turnover. Other potential sanctions include naming and shaming, a ban from public procurement and injunctions.

Other issues:

• The directive excludes downstream sales activities from due diligence efforts, despite downstream due diligence being an established part of international soft law standards on human rights due diligence.
• The deal includes the obligation for companies to carry out meaningful engagement including a dialogue and consultation with affected stakeholders, as one of the measures of the due diligence process.
• The provisional agreement clarifies the definitions of human rights and environmental impacts and has specified certain impacts in the Annexes. Importantly, the directive now defines environmental impacts as any measurable environmental degradation, such as harmful soil change, water or air pollution, harmful emissions or excessive water consumption or other impacts on natural resources.

Next steps in the legislative process

The provisional agreement will need to be endorsed and formally adopted by both the European Parliament and EU member states and then published in the Official Journal of the EU following a legal-linguistic review. The directive will have to be transposed into national law within 2 years following publication in the Official Journal, which is also when it will enter into force for large companies. Smaller companies in high risk sector will need to comply with the directive within 4 years following publication in the Official Journal.

What can business do?

European and third-country companies operating in Europe should start preparing for the CSDDD, including by conducting risk analysis of their value chains and incorporating sustainability and human rights considerations into their corporate policies and contracts with suppliers.

Sustainability and human rights due diligence is not solely a reporting exercise: it is a journey. It requires a shift away from traditional risk management strategies to a focus on rights and perspectives of those who may be affected by the operations of the company and others in their value chain. Companies would be well advised to anticipate the transposition of the Directive into national legal systems and make sure that a right and environment respecting culture is embedded in their operations, so that the due diligence process becomes less onerous when the standard comes into force.

The proposal also highlights the potential need to collaborate with others, including through multi-stakeholder initiatives. Businesses who do not already do so should also take stock of opportunities in this area.

How can DLA Piper help?

The complexity of global supply chains and a mix of national and European existing and upcoming due diligence rules might pose major challenges for businesses. As this is a directive, all EU member states will have to transpose it into national legislation, and there will be national regulators too, potentially creating differences in enforcement regimes. The DLA Piper Business & Human Rights team and our sustainability supply chain experts can help you to navigate the fast-changing regulatory environment, identify risks and opportunities, support in developing human rights due diligence policies, including codes of conduct and grievance mechanisms, and updating contracts with your business partners.